New World Order

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Sir David Tweedie is on a quest. The 59-year-old chairman of the International Accounting Standards Board (IASB) is overseeing the development of a single set of international accounting standards for the European Union (EU) by March and intends to converge those standards with U.S. rules.

Can it be done that quickly? It must be, according to Sir David. The engine of capital formation and investment has been stalled long enough by the anachronism of 26 separate European accounting methods, with another in America. Developing a single international system is “not about arcane bookkeeping matters,” says the former head of the UK’s accounting standards board. “It’s really about something much bigger.” Indeed, what the IASB is really targeting when it designs an accounting system for the world “is inward investment, growth, employment, and world trade,” he says.

The accounting scandals infecting both the New and Old Worlds give convergence more urgency. While Sir David won’t blame the Enron and Parmalat fiascos on an absence of international standards, he believes that some frauds would be much harder to pull off. Having a set of standards based on principles, rather than mere rules, might dissuade executives from simply “checking the boxes and not looking at the whole picture.”

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Sir David’s quest, however, has not been uniformly well received. There’s been much displeasure among European banks and the French government over the new rules for financial instruments. And the implications for expensing stock options have already met opposition in the States. Meanwhile, critics everywhere charge that without a European enforcement agency on the scale of the U.S. Securities and Exchange Commission, the rules will lack teeth. Sir David says that a plan to address enforcement is in the works.

He firmly believes that now is the time for international standards. In January, during a break at an IASB meeting in London, he sat down with CFO deputy editor Lori Calabro and CFO Asia editor Tom Leander to discuss the board’s hopes and his vision of a “three-legged-stool” arrangement—rules combined with good corporate governnace and auditing standards—for deterring abuses.

The IASB promised a workable set of standards by March, and the European Commission mandated that all European companies switch to international standards by 2005. How has the process evolved?

When we started in the summer of 2001, we inherited 34 standards from our predecessor body [the International Accounting Standards Committee]. Now, of those inherited standards, 30 had been an attempt to get together with the International Organization of Securities Commissions [IOSCO] to produce standards of appropriate quality, so that users could list on any stock exchange worldwide. But 14 of the standards were heavily criticized. Then, only about a month or two after we began, the EU announced this 2005 deadline. So we had a choice. We knew we had to fix these [inherited] standards, if international standards were going to be acceptable to New York and the SEC. But we also had the 2005 deadline. So should we just gradually change them, meaning that anyone coming on board would have to change twice in a matter of a year or two? Or should we have a real blitz on these standards, and really change them? That’s what we did. We ended up publishing in November, and we actually changed 17 of the 34—pretty fast for a standard setter in two and a half years.

Are the changes drastic?

We’ve tried to keep the fundamentals as best we could. But we did make changes. And we also produced a standard last year [that covers] what you do the first time you switch to international standards. Broadly speaking, you have to show in 2005 all the assets and liabilities that we require, measured as we require them, with certain cost-benefit allowances. We are not, for example, going to make you undo all business combinations you’ve done before.

The upgrades were to be completed in enough time for companies to meet the 2005 deadline. Is there any flexibility?

None.

None?

They’ve known for ages that it was coming. We’ve had the standards up on our Website since October. We said here are the 17 we altered. There may be cross-reference differences, which is why we aren’t publishing them officially. But all the standards are here. So they’ve had a year before they really had to do this. There are two complicated standards—the financial-instrument standards—so we’ve said don’t do the comparatives. But basically, we were given the 2005 deadline, so we have to meet it.

There is also the ongoing convergence project with U.S. accounting standards. Is there any tension between the standards you’re publishing and the ones the United States intends?

Not really. Take share-based payments. We are going out with one standard, but there’s a very similar one in the U.S. There’s a slight difference in the tax situation [concerning allocation methodology for the income tax benefit]. The Financial Accounting Standards Board is going to describe what we do for tax and ask [for feedback], and if the response suggests that the U.S. is right, then we’ll look at whether we should change ours. And if we don’t think the U.S. is right, we should argue until we’ve gotten them both the same. There is a willingness to do that.

So you don’t think there’s a problem with being on two different schedules?

We’re going to have this [scheduling conflict] for a year or two. But we want to eliminate the differences [between standards]…. And what our staffs have done is put the standards side by side, and say which is the better one. Then they’ve proposed to the board that whoever has the weaker standard should just switch. And while we’re not going to go into all the detail in the U.S., we’re going to make sure the principles are the same. Discontinued activities are one example. We came to the board and said, here are the differences; we think that one is better—fine, do it. We went through in one meeting and [put it] out for exposure. The U.S. issued four [exposure drafts] in December dealing with things like earnings per share, inventories, and restatement of accounting policies. There are others on long-term/short-term liabilities recognition and exchanges of assets. They’re all there. We’re not going to try to polish these standards; we just want to get rid of the differences. And it may be that you say, well, you could improve on this. We’re not even going to try. Just do it. Get rid of the differences.

Is that ideally how convergence works?

It is how the process works. We had an interesting time, though, on the business-combinations standard concerning the date a combination should start—the day you make an agreement or the day the control actually passes. Originally, we went for agreement date and the U.S. went for control date. Then we both re-debated and, unfortunately, we both changed. So we had to come back to the joint meeting and have a joint vote. It ended up 11 to 10, so we just turned to the 10 and said, does it matter? And that was it. That’s how we are trying to do it.

This whole process seems fairly amicable. When CFO reported on this four years ago, observers thought it would be fraught with tension.

The boards get on well. The staffs get on well. The big problem you get is if one guy has written the standards, and if you take something out, he may get very defensive about it. But a lot of these standards are quite old. The newer ones have been coming together anyway. And in this situation, the people making the decisions aren’t those who have invested all the time in writing them. It is easier when people are neutral, quite frankly. Plus, we are very lucky to have on our board Jim Leisenring, who is the former vice chairman of FASB, and Tony Cope, who resigned from FASB to join us. One of our board members—Bob Herz—became the chairman of FASB. So there’s quite a link; they’re internationalists.

Has the political will been assisted, say, by the Enron scandal?

Enron was a blow to the solar plexus in America. It wasn’t a case that accounting standards were wrong. As Sarbanes-Oxley proves, corporate governance was the issue. Parmalat is the same—they’re just cheating. And, yes, you could say that there were certain issues, such as special-purpose vehicles, that we could improve upon. But broadly speaking, they just broke the rules. There’s nothing we could do about that. Nonetheless, there was a shakeout. And part of the issue that came out was, wouldn’t it be better if we didn’t have a great list of rules, so that people could just check the boxes and not look at the whole picture?

Still, the principle structure you are promoting requires enforcement. And that’s been a problem in Europe.

The European Commission is working on it. It’s not there yet. It is in some countries and not in others. But each country will have to do something, and I suspect the securities regulators know that this has to happen.

If there are international standards, though, wouldn’t it make sense to have one enforcement body overseeing them?

But we can’t do that. It has to be the securities regulators.

But doesn’t the lack of an enforcement arm deter what you are doing?

No, I see it as a three-legged stool. We have accounting, auditing, enforcement—or corporate governance. We can supply only one leg of that stool, and our job is to do the first bit right. [The International Federation of Accountants] is doing the second part. It’s up to the IOSCO and the regulators to do the third. All I can do is produce the rules.

Just as Enron moved the convergence process along, are Europe’s scandals now helping the process internationally?

They will make it easier. With Parmalat, most of the problem is fraud. But [you have to ask] what has helped them pull off the fraud. Have they not consolidated certain things that should have been consolidated? Are there special-purpose entities? Have they been playing games with derivatives? Are they calling debt equity? People now see why we [need rules]. It’s heightened the awareness that accounting matters.

Were you surprised by Parmalat?

No, I’d been expecting it. We could not have been isolated from a thing like that. When you get booms like we had in the 1990s, [crooks] can hide anything going upwards because the cash is always coming in. Once it starts going down, and the cash isn’t there, then they start getting desperate and trying to hide the holes.

Were you at least surprised that it was cash at the crux of this fraud?

Or no cash?

Supposedly that was the one line that could not be finagled.

Supposedly it couldn’t. You thought that. But it was always peculiar that people were asking why a company like that was going out seeking money when it had billions in the bank. It didn’t make sense.

Does this cast any doubt on the principles-based approach?

No. They really weren’t using our standards anyway. But that’s why enforcement is so important. We had some pretty lousy auditing in the UK in the late ’80s and early ’90s. And what really helped was that at the same time they set up the accounting standards board in the UK, they set up a peer-review panel. If someone complained about a set of accounts, the panel would look at it, and if it didn’t think it showed a fair presentation, the panel would ask the company to change it. If the company wouldn’t, the panel would then go to court and force a change. The beauty of it was that if [the company] had to republish the accounts, the costs of the court action would fall on the individual directors, not the company. Nobody ever went to court. But the publicity was phenomenal…. And what I think it showed was that if you are in real danger—if you make a bad decision as an auditor and you get caught—we are going to have a go at you. The second thing it did was force auditors to qualify more. And the minute they qualified, in went the enforcement arm; it was automatic. So it really raised the standards. No fine has ever done that. It was the pure threat of publicity. Lawyers would say, “If they come for you, cave in instantly, because all you can do when you go to court is fight and argue. You might win on the legal technicality; meanwhile, the Financial Times will slaughter you.”

Could international standards prevent some of the frauds that we have seen?

It could make it harder. But what you really need is good corporate governance internally. You have to have good audit committees that can ask the questions: What is a special-purpose vehicle? Do we want it? Do we not want it? That’s what we have to do together. So we can make it much harder, provided people are obeying the rules and the audit committees are doing their jobs.

You describe what you’re doing as “political accounting.” What do you mean?

The U.S. and the UK are used to having independent standard-setters who listen to the arguments and say, OK, on balance we think that. Europe isn’t. Other parts of the world aren’t. Plus, the Europeans have a mechanism whereby they get to endorse the standards. So, basically, they run instantly to the Commission if they don’t agree with us, and instantly the politicians are involved. The same way Congress [intervened] with share-based payments, but even more so, because every standard has to be agreed to in Europe. And that has brought a huge political element into it. Where the SEC and Congress intervene only by exception, here everyone who loses an argument is going to rush to the Commission.

But when your board was retooled in 2001, it was to insulate it from political interference. Has that happened?

Ultimately, we are not dependent on Congress or on the EU. We can say we’ve looked at the arguments worldwide; we’ve looked at what the standards are; we think that is the best answer. As Paul Volcker [chairman of the IASC Foundation, which oversees the IASB] said in the FT recently: the IASB is going to finish these standards in March; it’s up to you to take it or leave it.

In this universe of political accounting, are the preparers of financial statements a constituency you must sell to?

It’s quite interesting. There’s massive support for convergence. But that means people have to accept that the standards will change. A few years back we had a huge fight in the UK over pensions. There were pictures of me in the tabloid press as “the man who destroyed your pensions.” I just measured them. Basically, the UK standard says if you have a pension deficit, you show the deficit, whereas previously it was all smoothed away over 20 years. I’ll give you a very simple example: If you had a pension scheme with $40 million in assets and $40 million in liabilities, and the markets—and your assets—fell to $30 million, how would you show that? Under U.S. and international standards, they say that some of the $10 million is market noise. So what they do is measure that $10 million at 10 percent of whatever is higher: assets or liabilities. In this case, liabilities are $40 million, assets are $30 million, so that’s $4 million. Knock it off of $10 million and that’s $6 million. Then spread that over the working life of the employees, and you’re left with $600,000. Well, your deficit is $10 million. Now what signal does that give? I often say you might as well take the $10 million and divide it by the cubic number of miles to the moon and multiply by your shoe size.

Interestingly, when we started showing these 10 millions, it was right at the [bottom] of the market drop, and there was a lot of pushback. There were almost armies of CFOs marching to the standards board. But now they are managing their pensions, because they say you can’t afford to meet these promises. So how do we do it? People say that accounting shouldn’t change behavior. But that’s exactly what it’s got to do.

What’s your advice for CFOs—especially those already bogged down with Sarbanes-Oxley regulation?

Think about the objective. Ultimately, there isn’t any reason why a transaction in Boston should be accounted for any differently than one in Brussels or Brisbane. And if [they are accounted for in the same way] it’s going to open up the capital markets. Say you are on Wall Street, [reviewing] a Dutch company. You’ll have other things to think about, but accounting is not going to be one of them. That’s going to reduce the cost of capital. That will save a lot of money.

You have called this the “best chance in a generation” to get these standards passed. Is there anything you see that could derail it?

Political pressure. We can’t force people to do it. That could destroy [this effort]. But it will happen someday, because the markets want it. And, ultimately, you cannot beat the markets.